Inventory Management

Learning Objectives

• Understand the importance of inventory in the economy

and in the firm
• Major types of inventory and reasons for carrying them
• Major types of costs associated with inventory
• Approaches to managing inventory
• Inventory classification
• To discuss concerns with inventory management
2
 Inventory refers to stocks of goods and
materials that are maintained for many
Inventory purposes, the most common being to
Management satisfy normal demand patterns.

3
U.S. inventories are growing at twice the rate of sales

U.S. inventories are growing at twice the rate of sales (rsmus.com)

4
U.S. inventories are growing at twice the rate of sales (rsmus.com)

5
Major Types of Inventory
and Reasons for Carrying
Them
Types of Inventory and Rationales

1. Procurement (purchase discounts), production (long production run), and

transportation (freight rate discounts)
2. Demand- and supply-side uncertainties
3. Inventory costs associated with goods in motion during transportation time
period.
4. Inventory costs associated with goods in process during the manufacture or
assembly of a complex product.
5. Seasonality in raw materials supply (e.g. production, transportation), in
demand for finished product, or both
6. Inventory hold in anticipation that an unusual event (e.g. strikes, significant
price increase, extreme weather)
 How might different
organizational functions
have different inventory
management objectives?

Take notes and be able to

explain why?

• K. (n.d.). 10
The Importance of Inventory in
Other Functional Areas
Objectives of the finance area might conflict with marketing
and manufacturing objectives. A more subtle conflict
sometimes arises between marketing and manufacturing as
the long production runs can cause shortages of some
products needed by marketing.

Marketing
• In favor of holding sufficient, or extra, inventory to ensure
product availability to meet customer needs and new
product offerings for continued market growth.
Manufacturing
• In favor of long production runs of a single product with
minimal changeovers to lower labour and machine costs
per unit, resulting in high product inventory levels.
Finance
• In favor of low inventories to increase inventory turns,
reduce liabilities and assets, and increase cash flow to the
organization.
Inventory decisions drive other business activities like:
• Warehousing
• Transportation
• Materials handling
Inventory
Classifications
13
 Cycle or Stock Based

Safety or Buffer Stock

Inventory Pipeline or In-transit

Classifications
Speculative

Psychic Stock

14
Cycle or base stock

refers to inventory
that is needed to
satisfy normal
demand during the
course of an order
cycle

15
 is inventory that is en-route
Pipeline or in- between various fixed facilities
transit stock in a logistics system such as a
plant, warehouse, or store.

16
This Photo by Unknown Author is licensed under CC BY-SA
Speculative stock

refers to inventory
that is held for several
reasons, including
seasonal demand,
projected price
increases, and
potential shortages of
a product
17
Psychic stock
is inventory carried to stimulate demand (retail)
I.E. end aisle display or product by the cash
18
Inventory Costs

19
Inventory Costs
Inventory cost should factor into an organization’s inventory management policy and
include:

• Inventory Carrying Cost

• Inventory carrying costs incurred by inventory at rest and waiting to be used. Four
major components: Capital cost, Storage space cost, Inventory service cost, and
Inventory risk cost.
• Ordering and Setup Cost
• Ordering cost refers to the expense of placing an order, excluding the cost of the
product itself. Setup cost refers to the expense of changing/modifying a
production/assembly process to facilitate line changeovers.
• Expected Stockout Cost
• The cost associated with not having a product/materials available to meet
customer/production demand. Most organizations hold safety or buffer stock to
minimize the possibility of a stockout and costs of lost sales.
• In-transit Inventory Carrying Cost
• Generally, carrying inventory in transit costs less than in warehouses. But, in-transit
inventory carrying cost becomes especially important on global moves since both
distance & time increase
20
 Carrying Costs / Holding Costs

Inventory carrying cost is the total of all expenses

related to storing unsold goods. The total includes
intangibles like depreciation, interests, insurance and
lost opportunity cost as well as warehousing costs.

A business' inventory carrying costs will generally total

about 20% to 30% of its total inventory costs

$1 Million 20% carrying cost = $200K

21
 Inventory carrying cost formula
(Capital + Taxes + Insurance + Warehouse Costs + (Scrap –
Recovery Costs) + (Obsolescence Costs - Recovery Costs))
Average Annual Inventory Costs

22
Ordering & Set Up Costs

Ordering costs are the expenses incurred to create and

process an order to a supplier. These costs are included in
the determination of the economic order quantity for an
inventory item.
Examples of ordering costs are: Cost to prepare a purchase
requisition.

• Fixed costs remain the same for any order (IE Computer used
to process the order).
• Variable costs change. (IE. Resources used to place the order,
receive the order)

23
Inventory ordering costs formula

Fixed Costs + Variable Costs = Order Cost

• Fixed costs remain the same for any order (IE Computer
used to process the order).
• Variable costs change. (IE. Resources used to place the
order, receive the order)

24
Stockout Costs

Stockout cost is the lost

income and expense
associated with a shortage
of inventory. This cost can
arise in two ways, which are:
... When a company needs
inventory for a production
run and the inventory is not
available, it must incur costs
to acquire the needed
inventory on short notice.
This Photo by Unknown Author is licensed under CC BY-NC-ND

25
 • Customer agrees to wait for the stock
• Customer backorders the item
Effects of
• Customer cancels the order
Stockouts
• Customer cancels the order and is NO longer a
customer

26
This Photo by Unknown Author is licensed under CC BY
Cost of Back Ordering

Increased order processing

costs as the customer
service staff amends the
order to create a new
suitable delivery date.
In addition, there may be
additional shipping charges
if the order was part of a
larger delivery, then the
backorder will require
special transportation.
This Photo by Unknown Author is licensed under CC BY-SA-NC

27
Cost of Cancelled
Orders

This Photo by Unknown Author is licensed under CC BY

Customer has
most likely found
an alternative

This Photo by Unknown Author is licensed under CC BY-NC

28
 Cost of Losing a Customer

All profits tied to the

customer are gone

Inventory forecast for the

customer no longer
needed

Cost of finding a new

customer is high

29
 Which is worse?
Write down your answer explaining why?

3030
General Rules Regarding Stockout Costs

The higher the average cost of a stockout, the better it is for the
company to hold some amount of inventory (safety stock) to protect
against stockouts. Example – just-in-time delivery penalties for
suppliers.

The higher the probability of a delayed sale, the lower the average
stockout costs and the lower the inventory that needs to be held by
a company. Example – customer wants a Mercedes Benz

31
 Cost of stockout formulation
Cost of a Stockout =
(Number of days out of stock x Average Units Sold per day x
Price per Unit) + Cost of Consequence

CS = (NDOS x AUSPD x PPU) + CC

$38,872 = (4 days x 12 items x $789)+$1000

32
 Alternative Loss Probability Average
Cost
Brand-loyal customer $0.00 $0.10 = $00.00
x

Switches & come back $37.00 $0.25 = $9.25

x

Lost customer $1,200.00 x $0.65 = $780.00

Average cost of stockout $1.00 $789.25

Each item will have its own Lost and Probability Calculation

Average Stockout Costs

33
Assumptions: order size – multiples of 10, $480 COGS/unit, carrying costs – 25%

10 units of safety stock saves potential stockout of $8000

The benefit of stock out costs avoided, decreases with larger

amounts of safety stock.

Carry costs vs Stockout costs 34

 STOCKOUT TOO MUCH STOCK

Which is worse?
Write down your answer explaining why?

3535
 3
6

Approaches
to
Managing
Inventory
 How much should inventory be
ordered?

When should inventory be

Managing ordered?
inventory
involves four key
questions: Where should inventory be
held?

What specific line items should

be available at specific locations?

37
When to Order and
How Much to Order
Economic order quantity (EOQ)

Deals with calculating the proper

order size with respect to two costs:
• Costs of carrying the inventory
• Costs of ordering the inventory

Determines the point at which the

sum of carrying costs and ordering
costs is minimized, or the point at
which carrying costs equal ordering
costs
38
Regardless of the approach selected, inventory decisions must
consider the basic tradeoff between cost and service.

39
 Inventory Management Approaches
Key Factors of Difference
Inventory management approaches differ in terms of three key factors.

Key Factors

1. Dependent vs. Independent demand. Independent demand is unrelated to the demand for
other items, while dependent demand is directly related to, or derives from, the demand for
another inventory item or product.

2. Pull vs. Push. The “pull” approach relies on customer orders to move product through a
logistics system, while the “push” approach uses inventory replenishment techniques in
anticipation of demand to move products.

3. System-wide vs. Single-facility solutions. A system-wide approach plans and executes

inventory decisions across multiple nodes in the logistics system. A single-facility approach
does so for shipments and receipts between a single shipping and receiving point.

©2021 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 40
 Inventory Management Approaches
Key Differences

Inventory Management Approaches

Key Factors of
EOQ JIT MRP DRP VMI JIC
Difference

Dependent vs. Independent

Both Dependent Dependent Independent Both Independent
demand

Pull vs. Push Both Pull Push Push Push Push

System-wide vs. Single-

Single facility Single facility System-wide System-wide Both System-wide
facility solution

©2021 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 41
 Inventory Management Approaches
EOQ Approach

Two basic forms of the economic order quantity (EOQ) model

Fixed Order Quantity

• Involves ordering a fixed amount of product each time reordering takes place.
• Also called two-bin model.

Fixed Order Interval

• Involves ordering inventory at fixed or regular intervals.
• Also called the fixed period or fixed review period approach.
• Generally, the amount ordered depends on how much is in stock and available
at the time of review.

©2021 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 42
Economic order quantity (EOQ) in dollars

EOQ = 𝐷𝐷𝐷𝐷𝐷𝐷/𝐶𝐶𝐶𝐶

EOQ = the most economic order size, in dollars

D = annual usage, in dollars

B = administrative costs per order of placing the order

C = carrying costs of the inventory (%)

I = dollar value of the inventory, per unit

EOQ Graph

44
EOQ model is grounded in the
following eight assumptions

1. A continuous, constant, and known rate of demand

2. A constant and known replenishment or lead time
3. A constant purchase price that is independent of
the order quantity
4. All demand is satisfied (no stockouts are allowed)
5. No inventory in transit
6. Only one item in inventory or no interaction
between inventory items
7. An infinite planning horizon
8. Unlimited capital availability.

45
 Inventory Management Approaches (1 of 2)
Additional Approaches: Just-in-Time (JIT)

Conference of the American Production & Inventory Control Society (APICS, 1988): 468. Reproduced by
Source Table 9.18: Adapted from William M. Boyst, III, “JIT American Style,” Proceedings of the 1988
Attitudes and
EOQ vs. JIT:
Behaviors
FACTOR EOQ JIT
Inventory Asset Liability
JIT systems are designed to
manage lead times and Safety stock Yes No
eliminate waste. Many JIT Production runs Long Short
systems place a high priority
on short, consistent lead Setup times Amortize Minimize
times. Lot sizes EOQ 1 for 1
Queues Eliminate Necessary
However, the length of the
lead time is not as important Lead times Tolerate Shorten
as the reliability of the lead Quality inspection Important parts 100% process
time.
Suppliers/customers Adversaries Partners
Supply sources Multiple Single

permission.
Employees Instruct Involve

©2021 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 46
 Inventory Management Approaches (2 of 2)
Additional Approaches: Just-in-Time (JIT)

• JIT commitment to short, consistent lead times and to minimizing or eliminating

inventories is JIT principal differentiator from the more traditional approaches.
• JIT saves money on downstream inventories by placing greater reliance on
improved responsiveness and flexibility.
• Successful JIT applications:
− Place a high priority on efficient and dependable manufacturing processes.
− Demand effective and dependable communications & information systems,
and high-quality, consistent transportation services.

©2021 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 47
What are some of the issues with the JIT


model
1. Supply Shocks . A sudden increase in the price of raw goods due
to issues with material sourcing, shortages, natural disaster, or
political upheaval can also pose a serious threat to the ability of
a company to service its customers effectively
2. Demand Shocks - The lack of backup inventory means
customers must wait for the company to receive supplies and
manufacture the product. This can mean extended delays,
dissatisfied customers, and potential forfeit of part or all of an
order if any supply chain issues arise.
3. Large Orders expect large discounts - Businesses that utilize the
JIT production strategy may pay more per item because they
must make smaller, more frequent orders that do not qualify for
these types of price breaks. Additional shipping and delivery
charges that accompany more frequent ordering can also
impact the bottom line , as well as on the environment.
4. Currency Strength – A sudden change in the currency buying or
selling a product directly affects the bottom line.
48
Just in Case (JIC) model

Just in case (JIC) is an inventory strategy where companies keep large

inventories on hand.
This type of inventory management strategy aims to minimize the
probability that a product will sell out of stock.
A company that uses this strategy typically has difficulty predicting
consumer demand or experiences large surges in demand at unpredictable
times.
A company practicing this strategy essentially incurs higher
inventory holding costs in return for a reduction in the number of sales lost
due to sold-out inventory.
There is also a risk of losing the inventory to accidents, obsolescence, and
degradation.

49
 Write down some issues
that may arise with the JIC
model

Which organizations would

you recommend use the JIC
model and why?

• K. (n.d.). 50
 Inventory Management Approaches (1 of 3)
Additional Approaches: Materials Requirements Planning (MRP)

MRP deals specifically with supplying materials and component parts whose
demand depends on the demand for a specific end product.

1. Ensure the availability of materials, components, and products for

planned production and for customer delivery.
2. Maintain the lowest possible inventory levels that support service
objectives.
3. Plan manufacturing activities, delivery schedules, and purchasing
activities.

©2021 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 51
 Inventory Management Approaches (2 of 3)
Additional Approaches: MRP

An MRP system is designed to translate a master production schedule into time-phased net
inventory requirements and the planned coverage of such requirements for each component item
needed to implement this schedule.

Source Figures 9.15 and 9.16: John J.

Coyle, DBA. Used with permission.
©2021 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 52
 MRP-based systems
Principal Advantages
• Maintain reasonable safety stock levels &
minimize or eliminate inventories whenever
possible.
• Identify process problems and potential
supply chain disruptions before they occur,
allowing necessary corrective actions.
• Base production schedules on actual demand
and forecasts of independent demand items.
• Coordinate materials ordering across multiple
points in a firm’s logistics network.
• Suitable for batch, intermittent assembly, or
project processes.
Principal Shortcomings
• Computer-intensive applications, making
changes difficult once the system is in
operation.
• Might increase ordering and
transportation costs as firms moving
toward a more coordinated system of
ordering product in smaller amounts.
• Not as sensitive to short-term
fluctuations in demand as order point
approaches
• Frequently become quite complex and
sometimes do not work exactly as
intended.
 With all the different
models what are some
concerns about Inventory
Management?

Take notes and be able to

explain why?

• K. (n.d.). 54
 ABC Analysis
Inventory Dead Stock
Management
Inventory Turnover
Concerns
Complementary or Substitute products

55
ABC Analysis

The ABC analysis is an

inventory categorization
method that assigns a
class to every item - or
SKU, or product typically
referred to as A, B and C A
based on frequently sold B C
or consumed items.

56
 Dead Stock
Inventory that doesn’t turn over – that doesn’t sell – is often referred to as dead stock

57
Potential Reuses
58
 Inventory Turnover
• Number of times that inventory is sold
in a one-year period.
• Compare with competitors
• Performance indicator from financials
• 12 times would be monthly, etc….

Inventory turnover = cost of goods sold

average inventory

59
 • Products that can fill the same need or want as another
product
• Products with many substitutes will suffer from stock
Substitute outs as customers will switch
Products • If there are no substitutes, the customer will just have to
wait

60
 • Inventories that can be used or distributed
Complementary together
Products
• Demand management issues
62
In SUMMARY
63
 Inventory refers to stocks of goods and
materials that are maintained for many
Inventory purposes, the most common being to
Management satisfy normal demand patterns.

64
 Cycle or Stock Based

Safety or Buffer Stock

Inventory Pipeline or In-transit

Classifications
Speculative

Psychic Stock

65
Inventory Costs
Inventory cost should factor into an organization’s inventory management policy and
include:

• Inventory Carrying Cost

• Inventory carrying costs incurred by inventory at rest and waiting to be used. Four
major components: Capital cost, Storage space cost, Inventory service cost, and
Inventory risk cost.
• Ordering and Setup Cost
• Ordering cost refers to the expense of placing an order, excluding the cost of the
product itself. Setup cost refers to the expense of changing/modifying a
production/assembly process to facilitate line changeovers.
• Expected Stockout Cost
• The cost associated with not having a product/materials available to meet
customer/production demand. Most organizations hold safety or buffer stock to
minimize the possibility of a stockout and costs of lost sales.
• In-transit Inventory Carrying Cost
• Generally, carrying inventory in transit costs less than in warehouses. But, in-transit
inventory carrying cost becomes especially important on global moves since both
distance & time increase
66
• Four major components of inventory carrying costs are: Capital cost, Storage space cost,
Inventory service cost, and Inventory risk cost.
• Choosing appropriate inventory model considers three key differences: Independent vs.
dependent demand, Push vs. pull distribution system, and system-wide vs. specific facility
decisions.
• Two basic forms of the EOQ model are the fixed quantity model and the fixed interval
model. The former is the most widely used, but with all systems, there are drawbacks.
• JIT model aims to minimize inventory levels, emphasizing frequent deliveries of smaller
quantities and alliances with suppliers or customers.
• JIC model goals prioritize risk management in the form of larger standing inventories.
• MRP and DRP are typically used in conjunction to manage the flow and timing of both
inbound materials and outbound finished goods.
• Inventory classification is vital to the initial step toward efficient inventory management.
68
 If you have any
questions, please ask
me in class or book an
appointment with me
during my office hours.

• K. (n.d.). 69
References
About us. (n.d.). Retrieved December 8, 2020, from http://www.luxottica.com/en/about-us

Brusuelas, J., Nguyen, T., & Graziano, M. (2023, February 22). U.S. inventories are growing at twice the rate of sales. The Real Economy Blog. https://realeconomy.rsmus.com/u-s-inventories-are-growing-at-twice-
the-rate-of-sales/

Controlling in logistics. (n.d.). Retrieved December 2, 2020, from https://www.intense.pl/en_en/blog/knowledge-base,402.html

Gerstell, E., Marchessou, S., Schmidt, J., & Spagnuolo, E. (2020, May 08). How COVID-19 is changing the world of beauty. Retrieved from https://www.mckinsey.com/industries/consumer-
packaged-goods/our-insights/how-covid-19-is-changing-the-world-of-beauty#

George, J., & Pillai, V. (2019). A study of factors affecting supply chain performance. Journal of Physics: Conference Series, 1355. doi:10.1088/1742-6596/1355/1/012018

Hayes, A. (2020, September 16). Supply Chain Management (SCM): What You Need to Know. Retrieved December 2, 2020, from https://www.investopedia.com/terms/s/scm.asp

Langley, C. J., Novack, R. A., Gibson, B. J., & Coyle, J. J. (2021). Supply Chain Management: A logistics perspective. Cengage.

Murphy, P. R., & Knemeyer, A. M. (2018). Contemporary logistics (12th ed.). Harlow, England: Pearson.

Murray, M. (n.d.). Learn About Stockout Costs and Effects on Supply Chain and Logistics. Retrieved December 13, 2020, from https://www.thebalancesmb.com/stockout-costs-and-effects-
2221391

Ovenden, J. (2016, September 01). 5 Great Supply Chain Failures: Articles: Supply Chain. Retrieved December 3, 2020, from https://channels.theinnovationenterprise.com/articles/5-great-
supply-chain-failures

Tadepalli, M. (n.d.). Role of Technology in Supply Chain Management. Retrieved December 3, 2020, from https://www.directivegroup.com/ideas/tools/news/blog/role-of-technology-in-
supply-chain-management/

What is Logistics Management? - Definition from Techopedia. (n.d.). Retrieved

Ordering Cost: Formula: Example: Cost Associate. (2020, February 28). Retrieved December 13, 2020, from https://accountinguide.com/ordering-cost/

Responsible sourcing – Microsoft CSR. (n.d.). Retrieved December 8, 2020, from https://www.microsoft.com/en-us/corporate-responsibility/responsible-sourcing

(n.d.). Retrieved from https://k2sourcing.com/sourcing-advanced-auctions.php?gclid=CjwKCAiAn7L-BRBbEiwAl9UtkOzg2VyjbcjCBrgDfRYqxzg4-

DER6L_ZH2G2BOWSeMIkqzBLs0LGQhoCq7sQAvD_BwE fromhttps://www.techopedia.com/definition/13984/logistics-management

Sme, S. (2020, March 18). Role of Procurement within an Organization: Procurement : A Tutorial: SCM: Supply Chain Resource Cooperative (SCRC): North Carolina State University. Retrieved
December 8, 2020, from https://scm.ncsu.edu/scm-articles/article/role-of-procurement-within-an-organization-procurement-a-tutorial

Speirs , D. (2020, December 08). No Christmas trees, no Christmas trees - the lots are empty as can be. Retrieved December 8, 2020, from https://www.winnipegfreepress.com/arts-and-
life/life/no-christmas-trees-no-christmas-trees----the-lots-are-empty-as-can-be-573323231.html

Team, T. I. (2022, December 22). What are the main problems with a JIT (Just in time) production strategy? Investopedia. Retrieved February 15, 2023, from
https://www.investopedia.com/ask/answers/040215/what-are-main-problems-jit-just-time-production-strategy.asp

Tuovila, A. (2020, September 07). Inventory Carrying Cost Definition. Retrieved December 13, 2020, from https://www.investopedia.com/terms/c/carryingcostofinventory.asp

WTO. (n.d.). Top 20 export countries worldwide in 2017 (in billion U.S. dollars). In Statista - The Statistics Portal. Retrieved June 7, 2018, from
https://www.statista.com/statistics/264623/leading-export-countries-worldwide/.
70
Www.fibre2fashion.com. (n.d.). The Bullwhip Effect. Retrieved December 8, 2020, from https://www.fibre2fashion.com/industry-article/7852/the-bullwhip-effect